3 Reasons Why China Will Continue to Crater in 2013

While China's still growing, that growth is slowing and disappointing

This weekend, China reported some important economic data.

Unfortunately for emerging market and commodity investors, nearly all of them disappointed.

As a result, the SPDR S&P China ETF (NYSE:GXC) is off almost 2% today and is down roughly 10% since Jan. 1 — a very ugly performance considering the double-digit move for the S&P 500 in the other direction. Some of the top holdings in GXC have been even uglier in 2013. These include:

This is a big deal, since 2012 was all about China’s risk of a “hard landing” amid real estate bubble fears and concerns that manufacturing growth had leveled off. Furthermore, there remain systemic concerns about an aging Chinese population and a “demographic time bomb” thanks to the longstanding one-child policy that has skewed the population much older.

The recent slowdown has some worried that the “stabilization” we saw in late 2012 to avert a hard landing was in fact just a head fake — and that recently improving data has already lost momentum.

Here are the big numbers to watch:

China GDP: This is the biggie. Q1 GDP slowed to 7.7%, well below the median forecast of about 8% across experts polled by the Wall Street Journal. What’s worse, that’s also down from 7.9% growth in Q4. The icing on the cake: An analyst at Nomura recently revised down full-year GDP forecasts for 2013 to 7.5% from 7.7% previously. You might think 7%-plus growth is nothing to get bearish about … but consider that nearly the only engine of economic growth during the Great Recession was China. The pressing need for China’s power coupled with a big miss on expectations is a very bad combination.

Manufacturing Malaise: Beyond the broad GDP issues, there’s concerns about China’s industrial production after a recent and unexpected slowdown. Industrial output growth eased to 9.5% in Q1 2013. Again, that sounds impressive, but it’s down 2.1 percentage points from 11.6% growth in Q1 2012 — and 0.5 percentage points slower than the full-year growth registered across all of 2012 by the National Bureau of Statistics. The trend is clearly lower — especially when you consider that the monthly number for March was just 8.9%, up a mere 0.66% from February. And my favorite point: growth of state-owned enterprises expanded only 4.3%. When the command-and-control economy of China is struggling to grow its nationalized businesses, that’s about as bad as it gets. China is still very reliant on manufacturing — both to power exports and to power consumer spending — so this is a significant trend to watch.

Retail Sales Slow: Another misleading number is that China retail sales were up 12.4% year-over-year in Q1. Again, measure that vs. expectations and the nation’s previous track record, and you understand why it’s disappointing. The growth rate was down 2.4 percentage points from Q1 2012 and 1.9 percentage points from calendar 2012 retail sales growth. Worse? After being adjusted for inflation, retail sales rose just 10.8% in the period. With continued focus on government graft and wasteful spending, it’s unlikely we will see Beijing dish out the cash to correct this trend on its own. And given the slowdown in GDP, it remains unclear whether the private sector has the oomph to pick up the slack on the spending front.

So what’s the trade here?

Simply put, you should avoid China. Things there are ugly and could get even worse, so don’t bottom-fish just yet. Remember: Some big plays there like China Mobile have largely sat out the rally since 2009.

Commodities also are in deep trouble, since the manufacturing might of China is almost single-handedly driving demand while Europe and America struggle to get their mojo back. Steel, copper and aluminum aren’t likely to be in big-time demand unless Chinese industrial appetite picks up again … and if that appetite doesn’t pick up, they could stay soft for a very long time.

Related to that, keep an eye on commodity stocks like Alcoa (NYSE:AA) or Southern Copper (NYSE:SCCO), which will see already thin margins pinched further by falling base metal prices. This is not to say you shouldn’t diversify with some commodity stocks or international picks in your portfolio. But be responsible and very skeptical before adding to new positions.

And not to be to gloomy, but if China does crash hard in 2013, it’s going to be hard to completely hide from the impact. Asian markets sold off across the board after China’s bad GDP data and other reports, as did U.S. markets in early trading.

It might be time to get defensive — not just with Chinese stocks, but with your whole portfolio.